Do the math on savings rate vs. portfolio return rate

Discuss all general (i.e. non-personal) investing questions and issues, investing news, and theory.
Post Reply
CULater
Posts: 1123
Joined: Sun Nov 13, 2016 10:59 am

Do the math on savings rate vs. portfolio return rate

Post by CULater » Sun Apr 15, 2018 9:15 pm

If you're worried about shortfall, perhaps you should focus on how to to save more vs. hoping to get great investment returns from your retirement portfolio by loading up on stocks. Pascal's Wager - which choice has a worse potential outcome? (hint: it's not trying to work longer and save more).
Let’s assume John and Jane Smith are 55, with a household income of $100,000 and a woefully underfunded retirement account. If they would like to retire by age 65 they have 10 years to play catch-up. If John and Jane were to save 10% of their income and earn 8% on their investments, they would accumulate roughly $165,000 by the time they retire. Earning 8% per year would be helpful but may be difficult to pull off in the current environment of higher valuations and lower interest rates.

Now let’s assume they instead save 20% of their income but only earn 4% on their investments. Under this scenario, they would end up with almost $275,000. So over shorter time frames like this, a doubling of your savings rate leads to a far better outcome than a doubling of your investment returns. And the best part is people have control over how much they save, but no control over the performance of the markets.(my emphasis)
http://awealthofcommonsense.com/2018/04 ... shortfall/
May you have the hindsight to know where you've been, The foresight to know where you're going, And the insight to know when you've gone too far. ~ Irish Blessing

User avatar
#Cruncher
Posts: 2583
Joined: Fri May 14, 2010 2:33 am
Location: New York City
Contact:

Re: Do the math on savings rate vs. portfolio return rate

Post by #Cruncher » Mon Apr 16, 2018 12:32 am

The referenced article includes a footnote
1 Both of these examples assumes a 3% increase in wages per year but a static savings rate as a percentage of income.
Since the thread title says "Do the math ...", here is the formula from Finance Formulas as shown in this post that accounts for the 3% annual growth in the amount saved:

Image

So the $165,000 and $275,000 are calculated as follows:

Code: Select all

163,000 = 10000 * (1.08 ^ 10 - 1.03 ^ 10) / 0.05
273,000 = 20000 * (1.04 ^ 10 - 1.03 ^ 10) / 0.01
Without the 3% annual growth in the amount saved the formula reduces to the regular future value of an annuity formula:

Code: Select all

145,000 = 10000 * (1.08 ^ 10 - 1) / 0.08
240,000 = 20000 * (1.04 ^ 10 - 1) / 0.04

Post Reply